Whose Money Is It Anyway?

1. Whose Money Is It Anyway?

2. Introduction to Personal Finance When does the typical, average, salaried individual start thinking about money, investing, personal finance? • Tax-saving; Email from F/A! • Circumstances • Employee Chit-chat • Call from relationship Manager • Friendly neighbourhood insurance agent

3. Personal Finance Approaches • Tax-savings first Buy products or make investments in haste at the end of each FY • Product-first Seek out a product for a need without understanding/analyzing the need • Returns-first Maniacal obsession over returns without paying heed to long-term and short-term risks

4. Personal Finance Approaches • Needs first Thorough evaluation of needs … and wants! • Product-last We do not search for products. We narrow down a type of product and then select one from that type • Tax-planning incidental Select a product from the chosen category that saves tax.

5. Personal Finance Approaches • Tax-savings first • Product-first • Returns-first • Needs first • Products-last • Tax-planning incidental Goal-based investing

6. Goal-based investing • List all known ‘needs’ and ‘wants’ • Classify them in order of importance • Classify them as per duration • Analyze each need/want. Determine how much we need to invest • Determine how much we can invest(!) • Decide on an approach • Find suitable investments • Invest • Monitor; Manage – A life long exercise!

7. First, we need to build a moat! Caerlaverock  Castle, Scotland. Source: Wikipedia Random Ramblings

8. 1. Protection against …. • Death of breadwinner(s) Solution:Life Insurance • Inflation-proof income to manage monthly expenses at least until kids go to a job • School fees • College fees • Marriage expenses • Other liabilities Product:Pure Term Life Insurance until retirement

9. 2. Protection against …. • Hospitalization of family members Solution:Medical Insurance • History of illness • Age of dependents • College fees • Typical room rents in neighboring hospitals Note:Enhance premium annually

10. 3. Protection against …. • Emergency expenditures Solution:Rainy day fund • Monthly expenses x 12 • Medical emergencies • Liabilities Products:SB account; Online FDs, Liquid funds. No credit cards! Key:Returns are irrelevant; Taxation is secondary; Ability to replenish

11. 4. Protection against …. • Disability Solution:Accident Insurance • Must if job is not permanent • Must for professionals and businessmen Products:Get from general insurer not from bank! Key:Read policy document before buying

12. 5. Protection against …. • Critical illness? Solution:CI insurance • Complex products • Better off starting a corpus for medical expenses – treat as a long term goal

13. Cash Flow Analysis: Creating a Zero-based budget • Zero-based budget: “One in which every dollar is assigned a role” – Dave Ramsey • No money left at the end of the month! • Live ‘hand to mouth’ because of investing! • No lump sums allowed!

14. Zero-based budget • Step 1: List all sources of income • Step 2: List all monthly expenses • Step 3: List all annual/recurring expenses • Step 4: Listpresent and future liabilities • Step 5: List present investments (incl EPF) • Step 6: Determine amount available for investment (incl EPF)

15. Recurring Expenses • Insurance premium, school fee, AMC fee etc. • Returns: irrelevant • Taxation: Irrelevant • Instruments: SB acct; RDs; Liquid funds; Arbitrage fund(?) …

16. Future Expenses: aka financial goals! • List all expected expenses in future Expenses after regular income stops aka ‘Retirement’ Expenses before income stops

17. Dividing the goal timeline ~ 5 years Save Invest

18. Power of non-compounding Power of compounding does not matter for ~ 5Y or less

19. Saving vs. Investing ~ 5 years Saving Investing Importance grows With duration Choose not to Worry Inflation Importance of beating Inflation, grows with duration Choose not to worry Returns Importance grows With duration Choose not to worry Taxation

20. Short-term Goals: determining how much to invest • What is the current Cost ? • Take all expenses into account • As accurately as possible Use an inflation of 8-10% (more for a safety margin) Return = post-tax interest rate of FD or RD

21. Short-term Goals: selecting instruments • Focus on nature of taxation: • Tax upon maturity/redemption (mutual funds) • Tax each financial year (RD/FD) • As per slab; with indexation; flat rate; Prefer: Tax upon redemption with indexation (debt mutual funds)

22. Note on indexation benefit • Capital gains = Sale Price – Purchase price • If the purchase was made 3Y ago, Inflate purchase price using cost inflation index • (Sale Price – Inflated Purchase Price) Can be negative • long-term capital losses can be set off against long-term capital gains

23. Short term capital loss (both in equity or debt fund) Offset against long term capital gain (debt funds) short term capital gain (equity or debt funds) long term capital loss (debt funds) Offset against long term capital gains (debt) long term capital gains in equity mutual funds are tax exempt … for now! Source: CafeMutual

24. Why not have some equity exposure? Is not 5 years long-term?! A primer on volatility Annual Returns

25. Compounded Annual Growth Rate Geometric Average

26. Compounded Annual Growth Rate Geometric Average

27. XYZ Monthly Income Plan Fund Equity Exposure: 11.5% to 15.1% Cash Exposure: 41% to 85% Rest Bonds

28. 5 year CAGR 6.2% Assuming no fluctuation from debt component!

29. Monthly Income Plan Funds 5 year returns: 5.6% to 13.6%